Customer differentiation with shipping as an ancillary service? free service, prioritization, and strategic delay

Abstract

A service provider/retailer offers ancillary service (e.g., shipping by an online retailer) to two types of customers, impatient and patient, who may be heterogeneous both in their delay sensitivities and service valuations. She can use prioritization and/or strategic delay to differentiate them by offering two service classes and charging different prices, potentially resulting in a split in which a single customer type selects both the classes. Her objective is to minimize cost while satisfying individual rationality and incentive compatibility conditions. We characterize the optimal solutions under both exogenous and endogenous capacities. We examine the conditions under which the following strategically important features of service delivery are optimal, and relate them to practical scenarios: (i) free service, (ii) single/differentiated service, (iii) split of customers, and (iv) strategic delay. We find that the presence of these features depends on (i) whether the retailer has limited or sufficient capacity and (ii) whether she sells fashion goods or staple products. A typical explanation for offering free service is that it increases demand from customers. We make an operational case for it by showing that even if demand does not change, free service is still optimal under some scenarios.